Europe's Dilemma: More Integration Or Less?

European governments seem to be having a hard time deciding whether to come together or drift apart at a time of economic uncertainty.

Years from now, historians will no doubt say this was a crisis waiting to happen. The people who came up with the idea of a eurozone stopped halfway. The participating countries would use a common currency, but they wouldn't have common tax and spending policies — a monetary union but not a fiscal union.

The debt crisis has now shown governments it's hard to have it both ways. Either they coordinate their tax and spending policies or they face a break up of their currency union.

Jacob Kirkegaard of the Peterson Institute for International Economics says it's like the Europeans built only half a house — and half a house can't stand on its own.

"Europe basically faces a choice," he said. "It can either dismantle the piece that they built earlier or they can build the other half of the house, so to speak."

Dismantling the European house would mean moving away from the euro — a move that could present serious problems. Governments could default on their euro currency debts. The banks that have loaned those governments money would themselves be put in jeopardy. Inter-bank lending could freeze up. U.S. banks would be hurt.

On the other hand, finishing that European house — adding the fiscal union to the monetary union — would also bring dramatic changes.

"Europe at its center would be dictating things like budgets and controlling deficits," said George Friedman, who heads Stratfor, a private intelligence firm. A fiscal union could even mean that a central European authority would be telling governments when to raise taxes, and by how much.

Kirkegaard says a change like this could require years of legal reform.

"Not only do you have to change the European treaty, which we know is in itself a multiyear process, but you quite likely also have to change the German Constitution," he said.

As that document is written, it strictly limits how the German government can spend money — provisions that would keep Germany from joining a European fiscal union.

Fundamentally, this is all a problem for the Europeans to resolve, but the U.S. is hardly indifferent to the crisis.

The Obama administration says it wants the Europeans to move ahead on building their common house. Treasury Secretary Timothy Geithner got himself invited to a European finance ministers meeting in Poland last Friday. Before going, he told CNBC the Europeans need to do what it takes "to hold this thing together."

"I think they recognize they've been behind the curve," he said. "And I think they recognize that they're going to have to do more to earn the confidence of the world that they have the political will to do this."

In Poland, Geithner pressed the Europeans, but there was little sign after the meeting that they were ready to take the kind of bold action Geithner was advocating.

Friedman says Geithner should not have been surprised.

"From the American point of view, this is a financial crisis. To the extent that it's a political crisis, the United States has to simply stand by and watch the Europeans play this out," he said. "We really aren't in a position to influence the political crisis."

With so much at stake and such strong arguments on both sides, it is hard to predict now which way the Europeans will go: toward more unity or less. But Friedman says one thing is clear: When this crisis is finally resolved, there will be "a new definition of Europe."

"We have seen Europe for 20 years in prosperity where many of these issues are submerged," he said. "We're now seeing a Europe in which they have emerged, and everybody is taking a very close second look at it."

That means there's uncertainty. And if there's one thing investors don't like, it is uncertainty. No wonder says Kirkegaard that stock and bond markets, in the U.S. as well as in Europe, reflect great anxiety right now.

"I think the markets are correct in their assessment that there is a number of problems facing the European economies that European political leaders have not owned up to," he said.

But time is running out and big decisions about Europe's future can't be put off much longer.